Buy / Sell Business on Financial Collapse

Contact Neufeld Legal PC for corporate transactional and legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Even when a business takes a significant financial hit, the entire business (or component parts of the business) may still have value that can be sold off, as it could not survive with its current ownership. The complexity associated with buying or selling a business is only exacerbated when the business has taken a serious financial loss, given the significant additional legal and financial considerations that need to be addressed in replacing the departing ownership.

From the Seller's Perspective, Selling after a Major Financial Setback

The seller must prepare for a rigorous examination of the business's finances and operations. The goal is to justify a sale price and demonstrate that the business has a viable future.

A. Transparency and Documentation:

• Honesty is the best policy. Be completely open about the financial setback. Hiding or minimizing the issues will only erode trust and could lead to a failed deal.

• Reconstruct Financial Statements. Clean up and normalize financial statements to show a clear picture of the company's performance. Remove one-time or non-recurring expenses to present a more accurate view of the business's underlying profitability.

• Gather all records. Have a well-organized data room with financial statements for the past several years, tax returns, bank statements, and documentation of all assets, liabilities, and contracts.

B. Valuation and Justification:

• Rethink traditional valuation methods. A multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) may not be the most appropriate method since the business has been unprofitable. Instead, consider:

  • Asset-based valuation: This method focuses on the value of the company's tangible and intangible assets (e.g., equipment, real estate, intellectual property, customer lists) minus its liabilities. This can be a strong approach if the company has valuable assets, even if it's currently losing money.

  • Market-based approach: Look at the sale prices of comparable businesses, but be prepared to explain why your business, despite its recent setback, is still a good investment.

  • Discounted Cash Flow (DCF): This method values the business based on its projected future cash flows. The seller must provide a credible and detailed forecast of how the business will return to profitability.

• Create a compelling narrative. Don't just present the numbers. Tell the story of the business's setback, what caused it, and what has been done to address the root problems. Present a clear, realistic plan for a turnaround under new ownership.

C. Strategic and Legal Preparation:

• Identify the source of the problem. Be able to articulate exactly what caused the financial setback—was it a failing product line, poor management, a one-time event, or market conditions?

• Show what you've changed. Demonstrate the steps you have taken to correct the issues. This could include cutting costs, improving operational efficiency, or securing new customer contracts.

• Address legal and operational issues. Settle any outstanding litigation, resolve environmental matters, and review contracts with key customers and suppliers. Address any issues like customer or supplier concentration, which can be a significant risk for a buyer.

• Consider a share sale vs. an asset sale. A share sale transfers the entire business, including all liabilities, while an asset sale allows the buyer to select specific assets and leave the unwanted liabilities behind. This is a critical point of negotiation, and sellers often prefer a share sale to offload all liabilities.

From the Buyer's Perspective, Purchasing after a Major Financial Setback

The buyer must exercise extreme caution and conduct thorough due diligence to understand the full scope of the financial problems and the risks involved.

A. Enhanced Due Diligence:

• Go deeper than the surface. Don't just look at the high-level financial statements. Dig into the details of transactional and product-level data to understand the true drivers of the business's performance.

• Identify the "why." Understand the specific reasons for the financial distress. Was it a one-time issue or an ongoing structural problem? Superficial answers are not enough.

• Assess management and key employees. In a distressed business, the management team may be a liability or a key asset. Determine who needs to be replaced and who is critical to the turnaround. Ensure that key employees will stay on after the transition.

• Investigate all liabilities. Look for hidden debts, outstanding legal cases, and environmental issues. Be aware that as a buyer, you could inherit these problems. A thorough review of all contracts, leases, and agreements is essential.

• Analyze customer and supplier relationships. High customer or supplier concentration can be a significant risk. Meet with key clients and suppliers to assess the strength of those relationships and whether they will continue under new ownership.

B. Negotiation and Deal Structure:

• Negotiate a realistic price. The initial offer is just the starting point. The due diligence process will likely uncover issues that warrant a price reduction.

• Consider creative deal structures. This could include:

  • Earn-outs: A portion of the purchase price is paid after the sale, contingent on the business meeting specific performance targets. This reduces the buyer's risk.

  • Seller financing: The seller provides a loan to the buyer to help finance the purchase.

  • Escrow provisions: A portion of the purchase price is held in escrow to cover any unforeseen liabilities or problems that arise after the sale.

• Draft a comprehensive purchase agreement. This legal document is crucial. Pay close attention to the representations and warranties, which are the seller's formal descriptions of the business's condition. The indemnity clauses will define who is responsible for paying damages if those representations prove to be inaccurate.

C. Planning for the Turnaround:

• Have a clear post-acquisition plan. The value of the distressed business lies in its potential for a turnaround. The buyer must have a detailed strategy for how they will inject new capital, improve operations, and return the company to profitability.

• Factor in additional costs. Be prepared for the costs of restructuring the company, making necessary investments in equipment or technology, and potentially laying off or hiring new employees.

When it comes to the legal component of corporate mergers & acquisitions, that is when the law firm of Neufeld Legal P.C. comes into play. Such that when your company is seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, contact us at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.

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